In an ideal world, a person will pay their taxes in full, on time, and without breaking the bank. Of course, we don’t live in an ideal world. In reality, many people fall short of this mark, and in such cases there are a range of options available to those that have trouble meeting their tax obligations. Among them is what is called an Offer in Compromise.
An Offer in Compromise is another term for settling with the IRS, where the taxpayer agrees to make a lump sum payout, and in return the IRS agrees to wipe the original tax liability. IRS Tax Attorney, available at https://www.irs.gov/payments/offer-in-compromise. Where it is possible, this sort of arrangement is preferable to the alternatives of having taxes declared uncollectible, or to a protracted installment agreement, whereby the taxpayer makes periodic payments on the amount in full.
The principal advantage of the Offer in Compromise is that the taxpayer is responsible for paying a lower dollar amount at the end of the day, namely because the IRS will agree to lower the total amount due in recognition of the costs of collection and the difficulties for some to meet their obligations in full. This basis for an Offer in Compromise is known as Doubt as to Collectability, and requires a showing that the liquidation of your total assets would not satisfy the amount owed to the IRS, and that you are financially unable to make payments consistent with the current IRS payment plan guidelines. You can also submit an Offer in Compromise on other bases, such as where you do not believe you actually owe the amount the IRS claims is due (Doubt as to Liability), or where you believe some extenuating circumstance should exonerate you from paying the full amount (Effective Tax Administration or “ETA”). In the case of ETA, you must support your offer with a narrative and supporting documentation that shows collecting the full amount would create severe economic hardship or would be unfair or inequitable. Id.
To make an Offer in Compromise, you will have to fill out Form 656, the official compromise agreement, as well as Form 433-A (Collection Information Statement). Be sure to make an offer that reflects your actual financial situation and your ability to pay. Prior to filling out the Form 433-A itself, remember to collect all the information you will need, including all relevant financial information including bank accounts, investment accounts, cash on hand, credit card accounts, and insurance policies. https://taxes.about.com/od/offerincompromise/a/form_433a.htm
Eligibility Requirements for Offer in Compromise
Offers in Compromise allow a person or business to reduce their tax liability and settle with the IRS up front. It sounds like a great deal, and if everyone could do it, they probably would. However, the IRS has certain eligibility requirements that a person or business must meet if they are to successfully submit an Offer in Compromise.
If you are an individual taxpayer and intend to submit an Offer in Compromise based upon Doubt as to Collectability (i.e. you are unable to pay), you must first show that you cannot pay, which is a function of your monthly income and your total assets.
Additionally, you must show that no personal bankruptcy proceeding is currently taking place. If such a proceeding is in progress, you will not be able to settle with the IRS on your own; rather, all such negotiations with the IRS must take place in the bankruptcy context, where the IRS will appear as a secured creditor of the debtor’s estate. https://www.irs.gov/payments/offer-in-compromise
Third, you must make sure that you have actually filed all federal tax returns that you are required to file. This raises the distinction between filing a tax return and paying your taxes – they are not the same! You should always file your tax return regardless of your ability to pay, and until you do, you will be ineligible to settle with the IRS by way of an Offer in Compromise.
Finally, if you are a business with employees and are required to make federal tax deposits for the current quarter and the two preceding quarters, and you have failed to do so, you will be ineligible for an Offer in Compromise.
Provided you have met these threshold requirements, you will be eligible to submit an Offer in Compromise, as long as you submit the $150 application fee, or a completed Form 656-A, which will operate to waive the filing fee based upon a showing of financial hardship, as well as a completed Form 433-A for individual taxpayers and Form 433-B for businesses.
Generally speaking, these requirements apply to both Offers in Compromise based upon Doubt as to Collectability as well as Offers in Compromise based upon Effective Tax Administration or “ETA,” but the ETA requires a narrative along with supporting documentation illustrating the hardship that would result from paying the amount owed the IRS.
Offers in Compromise based on Doubt as to Liability, which you should submit where you believe you do not owe the amount the IRS has attempted to collect, have different requirements, which are outside the scope of this discussion, but generally speaking, you will be required to provide a basis for your assertion that you do not owe the amount the IRS says you owe.
Pros and Cons of Offers in Compromise
If you have having difficulty paying your taxes, then an Offer in Compromise probably sounds like a pretty good deal – you can submit a few forms to the IRS, and before you know it your tax liability will be reduced substantially. That said, depending upon your financial situation, settling with the IRS through an Offer in Compromise may be second-best to a number of other options that you may want to consider.
For example, the IRS requirements for accepting Offers in Compromise are fairly stringent, and require you to have a very low monthly income and basically no assets whatsoever. https://www.irs.gov/payments/online-payment-agreement-application. Thus, you may end up wasting time and money on trying to settling with the IRS.
Additionally, it is important to keep in mind that the IRS cannot collect taxes from you forever; the Collection Statute Expiration Date (CSED) prevents the IRS from collecting taxes from you after 10 years. While that might be great news for some people, the IRS’ consideration of an Offer in Compromise “tolls” the CSED, basically freezing it in place while your submission is reviewed. In other words, if you are at 9 years and 11 months, it might be a bad idea pursue an Offer in Compromise. Finally, if you do successfully obtain an Offer in Compromise, you will need to be perfectly tax compliant for the next five years. https://taxresolutiontalk.blogspot.com/2011/12/pros-and-cons-of-resolving-irs-debt.html.
Of course, there are upsides to pursuing an Offer in Compromise as well. Aside from the most obvious of these—that the process has the potential to substantially reduce your tax liability to levels consistent with your financial ability to pay—an Offer in Compromise will put the collection activities of other creditors on hold. That said, ongoing collection activities such as garnishment of wages that began before the filing of the Offer in Compromise may continue after the filing.
When considering all of this, you should keep in mind that you can only weigh the pros and cons of Offers in Compromise in the context of the other options available to you; if you don’t pursue and Offer in Compromise, what will you do instead?
Vying for uncollectible status will allow you to be taken out of collections without fear of levy or garnishment, and you won’t have to pay a dime. However, the federal tax lien may be filed against you at any time, most likely the moment you have enough money to satisfy the original tax obligation, and frequent reviews of your uncollectible status might result in your removal from that status at any time.
Evaluation of Offers in Compromise
The IRS employs a very specific formula for determining whether to accept an Offer in Compromise. First, the Offer in Compromise must be for a sum that is greater than the reasonable collection potential (“RCP”) of the taxpayer in question. This RCP figure represents the taxpayer’s ability to pay the original taxes owed. Internal Revenue Service, Topic 204 – Offers in Compromise, available at https://www.irs.gov/taxtopics/tc204.html. Included in the RCP calculus is a taxpayer’s monthly income and assets. If, for example, the IRS decides that a person is able to pay the current amount due through a combination of a reasonable contribution from monthly income and liquidation of assets, then that taxpayers Offer of Compromise will likely be rejected.
Generally speaking, the IRS has identified three grounds for acceptance of an Offer of Compromise; doubt as to liability, doubt as to ability to collectability, and effective tax administration. While doubt as to collectability is based on the RCP calculus mentioned above, doubt as to liability and effective tax administration are somewhat less cut-and-dry. Doubt as to liability requires the taxpayer to show a substantial doubt as to the IRS’ calculation of the amount due. What is substantial is, of course, a determination to be made by the IRS, and it is up to you to provide the basis for this putative IRS error.
Meanwhile, the effective tax administration basis for an Offer of Compromise, while somewhat similar to doubt as to collectability in that in may involve financial hardship, is distinct in the sense that here, the taxpayer is actually capable of paying their tax bill. Rather, the taxpayer’s particular situation may provide a justification for reducing the total tax bill be reduced, for example, in cases where collecting the full amount would result in financial hardship, or where other extenuating circumstances present themselves. Once again, what constitutes extenuating circumstances,” or in the words of the IRS, what “would be unfair and inequitable because of exceptional circumstances,” is largely in the discretion of the IRS. Id.
Finally, it should be noted that the IRS has made recent changes to the calculation for determining the settlement amount, as it now only looks at a person’s disposable income over the next two years, when previously it looked at that income over four to five years when determining settlement amounts. Depending upon your situation, this may make Offers of Compromise more or less attractive, but you should speak with an attorney who can assist you in making that determination.
Please keep in mind the information and advice presented in this blog is not intended to be used as formal legal advice. Contact a tax professional for personalized tax advice pertaining to your specific situation. While we try and answer all parts of the question when we write our blogs, sometimes there may be some left unanswered. If you have any questions about your problems with the IRS, SBOE, FTB, or BOE, or tax law in general, call RJS LAW at (619) 595-1655.